ChFC Planning for Business Owners Practice Questions
Question 1
A business owner transfers company shares to a 3-year grantor retained annuity trust (GRAT) and dies in the second year of the term. What is the estate tax result?
- A. The trust assets are excluded from her gross estate, because the transfer was a completed gift for gift tax purposes
- B. The amount of trust assets needed to produce the retained annuity is included in her gross estate
- C. The remainder passes to the beneficiaries free of estate tax, and the annuity stops being taxed
- D. The trust assets are included in her estate at their original funding-date value
Show answer and explanation
Correct answer: B. The amount of trust assets needed to produce the retained annuity is included in her gross estate
If the grantor dies during the GRAT term, IRC Section 2036 pulls into the gross estate the portion of trust assets needed to generate the retained annuity. Much of the planned estate-freeze benefit is lost, which is the mortality risk of a GRAT.
- A. The retained annuity interest causes partial inclusion if the grantor dies during the term, despite the completed gift for gift tax purposes.
- B. This is the Section 2036 inclusion measured by assets needed to fund the annuity.
- C. The remainder is not shielded from estate tax if the grantor dies during the term.
- D. Inclusion is measured by the assets needed to support the annuity, not the original value.
Question 2
A sole proprietor with no employees funds a SEP-IRA. The plan lets the employer contribute up to 25% of an employee's compensation. After the self-employment tax deduction, what is the effective maximum contribution rate on the owner's net self-employment earnings?
- A. 25%
- B. 12.5%
- C. 15%
- D. 20%
Show answer and explanation
Correct answer: D. 20%
For a self-employed owner, the contribution is itself deductible in computing net earnings, so the 25% employee rate works out to an effective 20% of net self-employment earnings (after the deduction for half of self-employment tax).
- A. The 25% rate applies to employee compensation, not to the owner's net earnings.
- B. There is no 12.5% rule for sole-proprietor SEP contributions.
- C. This is not the algebraic result of the circular deduction calculation.
- D. The circular computation reduces the 25% rate to an effective 20%.
Question 3
Under IRC Section 101(j), for death proceeds from an employer-owned life insurance (EOLI) contract to retain income tax-free treatment beyond the employer's basis, which conditions must generally be satisfied?
- A. The employer must obtain the insured employee's written notice and consent before the policy is issued, and either satisfy an exception (such as the insured being a highly compensated employee/director within specified limits, or proceeds being paid to the insured's family/trust or used to buy out the insured's interest) or provide the required annual reporting.
- B. The employer must be a tax-exempt nonprofit organization that holds the policy for charitable purposes, and the insured employee must have been given written notice of the employer's intent to insure and the amount of coverage before issuance.
- C. The insured employee must be a rank-and-file employee earning below the Social Security wage base, and the employer must pay the full premiums from after-tax dollars while naming the employee's family as the beneficiary.
- D. The policy must be a term life insurance contract rather than permanent insurance, and the face amount must not exceed the employee's annual compensation, with the employer receiving the proceeds without any employee notice requirement.
Show answer and explanation
Correct answer: A. The employer must obtain the insured employee's written notice and consent before the policy is issued, and either satisfy an exception (such as the insured being a highly compensated employee/director within specified limits, or proceeds being paid to the insured's family/trust or used to buy out the insured's interest) or provide the required annual reporting.
IRC Section 101(j) generally requires the employer to obtain the insured employee's written notice and consent before policy issuance, and to either fall within an exception (e.g., the insured was a highly compensated employee or director within specified limits at issuance, or proceeds go to the insured's family, estate, or trust, or are used to buy out the insured's interest) or provide required annual reporting, in order for death proceeds on employer-owned life insurance to retain full income tax-free treatment. B, C, and D describe conditions that are not part of the 101(j) framework.
- A. Correct. Section 101(j) requires advance written notice and consent from the employee before issuance, plus satisfaction of either an exception (e.g., HCE/director carve-out within limits, or proceeds paid to the employee's family/trust or used for a buy-out) or the annual reporting requirement.
- B. Section 101(j) applies to employer-owned life insurance generally and is not limited to nonprofit employers; the employer's tax status is not a condition of the exclusion, and notice alone is not sufficient without consent and an exception or reporting.
- C. There is no requirement limiting the exception to rank-and-file employees below the Social Security wage base; one of the exceptions in fact covers highly compensated employees and directors within defined limits.
- D. Section 101(j) applies to employer-owned policies whether the coverage is term or permanent, and the framework requires notice and consent rather than waiving it; there is no term-only or compensation-cap requirement.
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A decedent's closely held business interest equals 45% of her adjusted gross estate. Which statement about IRC Section 6166 deferral is correct?
- A. It is unavailable, because the interest must exceed 50% of the adjusted gross estate
- B. It is available, and the full tax may be paid in installments over 15 years starting at death, with interest charged at the market rate throughout the period
- C. It is available, but the estate must first sell at least half of the business
- D. It is available: principal may be deferred up to 5 years, then the tax attributable to the business is paid in up to 10 annual installments
Show answer and explanation
Correct answer: D. It is available: principal may be deferred up to 5 years, then the tax attributable to the business is paid in up to 10 annual installments
Section 6166 applies when a closely held business interest exceeds 35% of the adjusted gross estate. The estate may defer payment of the attributable tax principal for up to 5 years and then pay it in up to 10 annual installments.
- A. The threshold is 35%, not 50%, so the 45% interest qualifies.
- B. The statute allows up to 5 years of deferral followed by up to 10 annual installments, not 15 years of installments from death, and a reduced interest rate applies to part of the deferred tax.
- C. Section 6166 does not require selling any part of the business.
- D. This states the 35% test, the 5-year deferral, and the 10-installment payout.